Everybody was excited about Facebook joining the stock market. Why was there so much hype and why was this a big deal?
IPO stands for Initial Public Offering. This means that a company sells ownership shares of the company to the public for the first time. It’s the first time people outside the company are able to buy a piece of the company. Companies sell stock or “go public” for a few reasons. In most cases, companies want to raise money to fund their business. Also, a company can legally have only 500 shareholders before selling shares in an IPO. This is basically why Facebook had an IPO. They were near the limit of investors they could have, so they decided to go public. Although there were some issues on the first day of trading, the stock traded at levels that made the company worth $100 billion. From that perspective, the Facebook IPO was one of the largest and most successful ever.
So then why were people disappointed with the IPO on that first day?
There are a few reasons. For one, the stock price only rose 23 cents for the day. Many “hot” technology IPOs have seen a rapid increase of up to 25% on the first day of trading, so some were upset that the stock didn’t “pop.” Frankly, this isn’t an issue to be concerned about. A stock is a share in a business. Facebook’s business didn’t increase rapidly in value that day, so there’s no reason the price should have skyrocketed by double digits. In a way, the small price increase tells us that the stock was fairly priced from the beginning.
But there was also a timing issue, right?
Yes. Facebook shares began trading later than they were supposed to. Trading typically begins at 9:30 a.m. for most of the market. IPOs typically start trading at least an hour later on their first day. Facebook was supposed to begin trading at 11 a.m. but it didn’t happen until 11:30 a.m. This error is similar to the first concern in that it’s a bit picky. Facebook has existed for years and will continue to exist. If you buy a stock, you typically expect it to be around for decades. 30 minutes is pretty minor in the grand scheme of things.
Trading didn’t go smoothly after it finally did start, did it?
Right. There were orders for the stock that were not completed. Some people that wanted to either buy or sell stock were unable to. And sometimes when a trade did go through, it didn’t happen at the expected price. This is a somewhat more serious issue. Investors were upset that they couldn’t get shares when they wanted for the price they agreed on. Many people said they lost money on this issue, but stock market officials have apologized and offered money to make things right. If you did not buy, sell or own Facebook shares on day one, it’s not an issue. The problem is over.
The one issue we haven’t touched on yet is alleged problems with the people who helped Facebook arrange its IPO. What are people saying went wrong?
Yes, there are allegations that the underwriters, those who help a company launch their IPO, improperly released information about Facebook’s business. The underwriters raise the money and set the price for the IPO. In order to properly set that price, they have to have a lot of information about the business—including information not available to the public. There’s nothing wrong with them having that information. The allegation is that the underwriters may have given some key information to some investors but not others—a big no-no. Specifically, it looks like Facebook’s business slowed down in the short term, which could lead investors to think the business was worth less than they previously thought. This could prove to be a very serious issue. Lawsuits may occur and doubts may arise about the real values of shares.
From your perspective, what’s the way to view the situation- what does it mean for TJMS listeners?
Here is how I rank these problems. Least importantly, it started trading late. If you’re late for a meeting, it doesn’t look great, but it’s a one-time issue. You apologize and move on, which we saw happen. The unfilled and misfiled orders are more problematic, because matching buyers and sellers quickly at the specified price is a core element of the stock market. Investors need to know that this was a one-time isolated incident. If investors can be convinced that it was, then there is no ongoing issue. The most serious issue involves the allegations against the underwriters and fears of insider trading. Late openings and botched trades happen and can be viewed as honest mistakes. Acting on inside information- if it did happen- is not honest. It is important to note that these errors have caused Facebook’s reputation to take a hit, but that the company itself has not been accused of wrongdoing in regards to the insider information problem. If you practice the type of investing that I believe in- long-term, patient investing, then these problems really don’t apply to you.
If you are a long-term investor the rational reason to buy Facebook stock is that you think its mammoth growth will continue. If this happens, you stand to make a lot of money over the next decade regardless of whether you bought the stock for $27 or $28. If its growth falters, though, you stand to lose a lot of money because of the high expectations built into the stock’s price. I think Facebook is a great company- amazing, actually-but personally I prefer stocks that have to jump over low hurdles rather than high ones.